Monthly Market Update: Have we seen the worst of it?

Tue 26 Jul 2022

We find ourselves in the midst of a once-in-a-decade paradigm shift for financial markets and the global economy.

Is this a time to be adding to risk?

There is always a point of capitulation for stocks and bonds, a place where a rout becomes opportunity. While we acknowledge that, in our quarterly investment committee we felt that this was not a good time to increase risks despite lower equity valuations and higher bond yields. Downside risk is still significant. The confluence of Quantitative Tightening, rising rates and an economic slowdown, contributes to the possible emergence of second order risks and dislocations currently not on the radar. Additionally we feel that equity valuations, while reduced, are still above their very long term average.

Instead, we focused on our bond exposure. We reduced our underweight in bonds, as we feel that bond yields are becoming more attractive. Our overall position is still an underweight one, with low duration risk, but at this point we felt that we needed to take some profit from this underweight and not try to exactly time the market turnaround.

The investment committee feels that the ‘Fed Put’, an unofficial pledge by the Fed that it will support risk assets, is still in effect. After all, the Fed has not proceeded with any significant removal of liquidity, via Quantitative Tightening just yet. So while it tries to curb inflation, its movements (or lack thereof) in the asset market may be betraying its true nature: that of a market-friendly monetary dove. Where is that Fed Put? It could be significantly lower, perhaps when the S&P 500 breaks the 3000 point limit. At current projected earnings, this would be near the traditional capitulation point for equities. Or the Put may be more relevant to the bond market. The Fed could intervene with more liquidity if it sees significant dislocations in the credit space.

However, until markets gain a clear upward direction again, we remain strategically cautious. We feel that this is not the time for complexity, risk or leverage. It is not the time to try and guess when the situation will reverse itself. It is a time of caution, diversification, liquidity and patience. Our long-term views remain flexible, as we don’t know what the world will look like in a few years. But we do know this: every decade in the past fifty years features some sort of capitalistic crisis and in each and every situation, capitalism successfully reinvented itself. Despite the volatility, we feel that investors should stick to long-term principles. They should still adhere to their risk profiles and trust that investing for at least 10 years in a diversified portfolio, at any given moment in time – even the worst of times, has very few probabilities of absolute loss, around 1.5%. The probability tends to zero after a loss such as the one we are experiencing.

George Lagarias – Chief Economist